Traditionally, exchanges for trading of financial instruments were physically localized on trading floors and involved “specialists” to create markets for particular financial instruments, matching buyers and sellers of such instruments, buying and selling for their own accounts, and controlling trading for the particular financial instruments. With the rise of electronic and automated trading of financial instruments, exchanges have grown on which professional broker-dealers have privileges to buy and sell on behalf of public customers as well as on their own accounts, subject to rules set by the exchanges, as self-regulatory organizations (“SROs”) approved by the Securities and Exchange Commission in the United States, such as the Boston Stock Exchange. According to such rules, some of these professionals are designated and afforded certain privileges as “market makers”, each having the responsibility to make a market in the trading of one or more instruments by always maintaining a bid to buy at a bid price and an offer to sell at an offer price. Typically in the automated exchanges, there may be competing market-makers for the same instrument, in contrast to the single specialist in traditional exchanges.
When a purchaser, typically through a broker, orders a purchase at “market”, a trade may be executed at the offer price set by one or more market-makers at the time. When a seller, typically through a broker, orders a sale at “market”, a trade may be executed at the bid price set by one or more market-makers at the time. Limit orders are bids or offers at a specified price that may not be matched by offers or bids (that is, “non-marketable”) until there is price movement by a market maker or by other market participants, typically broker-dealers. These orders are kept on a book according to exchange rules until matches are made and trades executed.
In the United States, a National Best Bids and Offers (“NBBO”) database is continuously updated with data from the order books of the various securities exchanges. NBBOs for equity option contracts are reported by the Options Price Reporting Agency (“OPRA”) currently in increments of $0.05 of price quoted as the price per share of the underlying equity instrument (generally 100 per option contract), as they are currently traded on the exchanges.
In the prevailing electronic marketplace for equity options established under such rules, at any given time, there are NBBOs which may be separated by a spread for an indeterminate period of time until bidders (buyers) and offerors (sellers) change their bids or offers by human or automated decision. It is desirable to close these spreads more rapidly through an improvement in price (raising bids and lowering offers).